No television cameras rolled to capture the moment. No grandstanding politicians ranted or corporate executives sat sweating under the lights on the witness stand. There was no talk of corporate jets in a packed courtroom or committee hearing—almost no drama at all. Yet according to some legal experts, one of the most important legal decisions of the financial crisis to date, at least as far as directors are concerned, was handed down in late February in the small town of Georgetown, Delaware.
With little fanfare, Delaware’s famed Court of Chancery dismissed a claim by Citigroup shareholders against current and former directors and officers that they had breached their fiduciary duty by failing to properly monitor and disclose risks arising from problems in the subprime lending market that resulted in massive losses.
It is the best news to come out of the crisis for board members who have had little to celebrate, say some lawyers. In his ruling, Chancery Court Chancellor William B. Chandler III made it clear he was not about to let the Delaware Courts become an instrument of the public’s emotional need to find a scapegoat for the financial mess. “Oversight duties under Delaware law are not designed to subject directors, even expert directors, to personal liability for failure to predict the future…” he wrote in his findings.
It is likely not the last word from the Delaware courts on who is or is not to blame for actions preceding and during the current financial crisis. But subsequent decisions can be expected to hew to Delaware’s sober, level-headed posture that has earned it its place far atop the corporate legal system for the last 200-plus years. Delaware lawyers and judges are adamant that the state will stay true to form and not engage in knee-jerk reactions to the nation’s financial crisis or potential threats of federal intrusion into corporate governance. “Even in this environment, we’re not in a panic,” says Delaware Supreme Court Chief Justice Myron T. Steele. “We’re not going to abandon fundamental principals that have served us well, or the methodology in applying these principles to keep the federal government at bay.” In fact, the Delaware courts have a history of keeping emotion and public passion from corrupting its decision-making process, say lawyers. Perhaps no decision demonstrated that fact better than the one handed down in 2005 by the Chancery Court in the case against the board of directors at Disney.
Delaware Rules
As Hollywood legend Sidney Poitier relaxed in the rotunda of the understated Georgian-style courthouse in southern Delaware, he could have been one of the out-of-town lawyers who frequently parachute into the state for corporate disputes in the Court of Chancery.
But Poitier, in his charcoal suit, was one of the star witnesses in a three-month trial that gripped the nation. The actor was in the rural community of Georgetown to be grilled about his actions as a director of The Walt Disney Co. He was on the hot seat, along with other directors, for awarding a kingly $140 million severance package to former Disney president Michael Ovitz, after Ovitz had served only slightly more than a year in the job.
As a director of Disney, Poitier was overseeing a Delaware company and, as such, was bound by the state’s corporate laws. The California-based entertainment giant is among the 63 percent of Fortune 500 companies and more than half of the companies on the New York Stock Exchange that have filed their certificates of incorporation in the state.
Delaware law governs the internal workings of these companies, including directors’ duties and liabilities. Because it is so dominant, Delaware state law is the de facto corporate law of the country. Over the years, court cases have drawn captains of industry to the state, from Texas oilman T. Boone Pickens, to Oracle founder Larry Ellison, to former Hewlett-Packard chief executive Carly Fiorina.
One-time FBI director Louis Freeh, a lawyer who heads a consulting firm in Wilmington that deals with corporate governance, ethics, and compliance matters, says in terms of jurisprudence, little Delaware is “leagues above its weight class…by every measure.”
“Delaware law is so powerful that I’ve been in Europe in the offices of general counsel and they’ve had a pile of Chancery Court opinions on their desk,” says Freeh, who also is a director of Bristol-Myers Squibb, a Delaware corporation.
Indeed, the state aspires to be the Tiffany & Co. of the incorporations business, says Steele. Its high-quality product is the state’s enabling corporation law that is nurtured, protected, and preserved by the state lawmakers. The state Division of Corporations, Court of Chancery, and Supreme Court are the service departments. “The state’s great advantage is its well-developed body of law dating to 1911 that is based on real cases focused on specific facts. Legislation divorced from specific facts that is applied across the board to every situation is unlikely to produce right or fair results,” says Steele.
Like Tiffany’s, Delaware works hard to protect its brand. Since 1899, when Delaware’s legislative body, the General Assembly, passed its management-friendly corporations act, leaders and lawyers have kept a watchful eye on the golden goose. Taxes and fees paid by corporations chartered for decades in the state have represented as much as a third of the state’s annual revenues. To stay on the cutting edge, Delaware has tweaked its constitution and corporate laws, and expanded the powers of Chancery Court.
Such seemingly opportunistic behavior has left Delaware open to a chorus of critics who, for years, have attacked the state as being the handmaiden of Big Business. They point to Delaware law, which gives directors broad powers to run the business and affairs of a corporation. In 1974, William Cary, a former chairman of the SEC, famously wrote that in its zeal to get revenues Delaware was leading a “race to the bottom” in corporate standards.
Delaware defenders counter that state lawmakers and courts always have done an exemplary job of weighing the needs of both management and shareholders to create stockholder wealth. “My personal sense is one of the reasons investors and managers trust Delaware is that everyone gets a fair shake and cases get decided on their merits,” says Vice Chancellor Leo Strine Jr., a judge in the Delaware Court of Chancery.
As the country grapples with its biggest financial crisis since the Great Depression, even some critics are saying Delaware has kept to the high road. “For a long time, Delaware was seen as very much tilted in favor of management in its law,” says William Clark, a partner at Drinker Biddle & Reath in Philadelphia, who wrote the 2007 shareholder- friendly statute for North Dakota. “But the courts have been moving to impose duties on directors that reflect the concerns of shareholders.”
As further evidence, Clark points to some proposed pro-shareholder amendments formulated by the state’s corporate lawyers that are expected to be introduced in the General Assembly in the coming weeks. They would give institutional shareholders more flexibility for proxy access.
One amendment would allow corporations to adopt bylaw provisions that would permit shareholders in an election of directors to have their nominees included in the corporation’s proxy materials. Another proposed amendment would allow companies to enact bylaw provisions to reimburse shareholders for proxy solicitation expenses. “That’s huge,” Clark says. “It’s a significant change to Delaware’s image of being pro-management.”
Building on the Past
Through a lucky twist of history for the state, Delaware managed to keep its ancient Court of Chancery–or court of equity–when other states were jettisoning them. Chancery Court, unlike a court of law, is based on principles of fairness. In medieval England, when the common law courts became bogged down with procedure, losing parties sometimes would appeal to the king, saying they should have won under rules of fairness. These appeals were turned over to the king’s lord chancellor.
The modern court is believed to have had its first major corporate litigation in 1911. Judges in the trial court try both fact and law. It does not handle criminal, tort, or family law cases. It is not bound by strict statutes of limitations. The court may issue temporary restraining orders, injunctions, or other forms of relief. Today, about 70 percent of the filings with the court are corporate or commercial law. Because the five judges spend about 80 percent of their time on these matters, corporate lawyers say they don’t have to spend time educating the judge. “In Delaware, you have a judge who knows the law as well as anyone,” says Stephen Radin, a partner at law firm Weil, Gotshal & Manges in New York. “That’s the beauty of Delaware–you’ve got a high level of judges.”
The court must be politically balanced and judges are appointed, not elected. When a vacancy occurs on the court, the state’s judicial nominating commission identifies qualified candidates and submits names to the governor. The governor makes the nomination, which must be approved by the state Senate.
The court develops its understanding of the boardroom by interacting with directors at director conferences and similar events, says Chandler. “These functions enable us to hear from actual directors about the concerns and problems they face, and it gives directors a chance to hear directly from the judges, in less formal settings, our views about the most problematic types of conduct by boards or the types of issues that we frequently see in court,” he says.
Corporate Fiduciaries
In the end, the state courts found that the Poitier and other Disney directors did not breach their duties of loyalty and care when they gave Ovitz a “breathtaking” golden parachute. While Chandler had harsh words for the Disney board, he ruled that Eisner and the board had made their mistakes in good faith, availing them of the protection of Delaware’s business-judgment rule. The rule shields companies, directors, and officers from liability as long as they uphold their duties of care and and loyalty.
The business judgment rule precludes the court from secondguessing decisions presumed to be made by informed, honest, and disinterested directors who are acting in the best interest of the company and its shareholders. Charles Elson, director of the Weinberg Center for Corporate Governance at the University of Delaware and a director at HealthSouth, says the rule is paramount. “On any board, most decisions you make are subject to the business judgment rule. So directors are keenly aware of Delaware law. Delaware law plays a role in every boardroom.”
The business judgment rule can be rebutted if it can be proved the board violated one of its fiduciary duties through fraud, bad faith, or self-dealing, says Chandler. The fiduciary duties owed by directors of Delaware corporations are duties of due care and loyalty. The duty of good faith falls under the duty of loyalty, the Supreme Court found in 2006. The duty of loyalty mandates that directors unselfishly protect and act in the best interest of the corporation and its shareholders.
Under duty of care, officers and directors must conduct themselves as an ordinarily prudent person would in his own affairs, including considering all material information reasonably available, Chandler’s 174-page opinion on Disney reads. Chandler reaffirms that attention to the best interest of the company is conduct the court continues to expect from directors. “Judges of this court expect directors to act with complete fidelity to the corporation, mindful of their role as stewards of the corporate enterprise seeking, honestly and in good faith, always to advance its best interests,” he says. “The definition of a good director begins with one word: Loyalty. Actions that are rooted in good faith judgments, made with integrity and conscientiousness, will be respected by judges, and are the cornerstone of our deferential business judgment rule.”
Directors Under Scrutiny
The job of director has become increasing difficult and risky. As shareholders have watched their wealth vaporize in the stock market, some have predicted that angry shareholders will be looking for directors’ heads on platters. “Given that so many American workers now depend on equity investments for retirement, it’s only natural to expect independent directors to come under scrutiny when a major corporation suffers a serious setback,” says Strine.
One form of scrutiny is likely to be litigation over whether directors lived up to their fiduciary responsibility to monitor the corporation’s management, he says: “Current events suggest that there will be an increasing focus by investors and plaintiffs on how boards used their time and talent to ensure that their corporations had procedures in place to ensure legal compliance and manage fundamental risks.”
Some lawyers say they expect more lawsuits involving the socalled Caremark standard, which refers to a 1996 derivative litigation in which plaintiffs wanted to hold directors liable for an alleged failure to exercise sufficient oversight. In a derivative lawsuit, a shareholder plaintiff sues directors or management on behalf on the company. The landmark decision created an incentive for companies to have effective compliance programs in place.
“Caremark was a seminal case on the duty of oversight,” says A. Gilchrist Sparks III, a partner with Morris, Nichols, Arsht & Tunnell in Wilmington. “You don’t want directors to be so risk averse they’re not going to be entrepreneurial or that you’ll scare away directors from serving.”
In the same month that the Court of Chancery dismissed most of the claims against Citigroup, Strine allowed a derivative case brought by shareholder plaintiffs of American International Group against former chairman and chief executive Maurice R. Greenberg and three former inside directors to proceed. Plaintiffs want to recover money from AIG as a result of damages suffered when it was revealed that AIG’s financial statements overstated the value of the corporation by billions of dollars. The plaintiffs allege that Greenberg and his inner circle orchestrated widespread illegal misconduct.
“At this stage, a fair inference arises that Greenberg and the Inner Circle Defendants employed their expertise in illicit ways that ultimately resulted in billions of dollars of harm to AIG,” Strine writes in the opinion. “Moreover, the pleading of direct involvement by Greenberg and the Inner Circle Defendants in many of the specific alleged wrongs gives rise to a fair inference that the defendants knew that AIG’s internal controls and compliance efforts were inadequate.”
In January, in a separate case, the Delaware Supreme Court upheld a Chancery Court ruling which found plaintiffs had failed to show that directors of Viacom, including Chairman Sumner Redstone, had breached their duty of disclosure by making material misstatements, omissions, and misrepresentations in the prospectus, as well as their duties of loyalty and good faith. Duty of disclosure is not independent, but falls under duties of care and loyalty.
“Delaware law is so powerful that I’ve been in Europe in the offices of general counsel and they’ve had a pile of Chancery Court opinions on their desk.” – Louis Freeh, Bristol-Meyers Squibb
Chandler says he doesn’t expect an onslaught of litigation similar to the Citigroup case in which shareholders alleged a failure of board oversight in making certain investments. “Am I expecting an avalanche? I haven’t seen it so far,” says Chandler. What he does see is a potential for more deal-related lawsuits, such as the recent Rohm and Haas Co. v. Dow Chemical Co. In that case, Rohm & Haas asked the Chancery Court to force Dow to complete a $15.4 billion merger. The case was settled just as the trial was about to begin. Deals such as the Dow and Rohm & Haas merger, in which there are significant changes in the financial markets between the time the merger agreement is inked and the consummation of the transaction, could lead to more lawsuits, he says. “There’s money out there for these deals to get made, but then the economic downturn can make these deals look bad,” Chandler explains. Such lawsuits could take two forms. The target company might want the deal enforced. On the other hand, purchasers might pull a so-called MAC, seeking to back out because of a material adverse business or economic change involving the company to be acquired.
Chandler says there could also be more litigation involving executive pay, a hot-button shareholder issue today. “I can see increasing litigation over some exotic forms of poison pills,” he adds.
Constant Attention
While Delaware’s lawmaking process leans toward the judge-made law in Chancery Court and the Supreme Court, the General Assembly also has a role in keeping the laws flexible and responsive, lawyers say. Consider the current amendments to the corporate statute proposed by the Delaware State Bar Association. The proxy reimbursement amendment is in response to a 2008 Delaware Supreme Court decision in CA Inc. v. AFSCME Employees Pension Plan, which involved reimbursement for reasonable expenses in connection with nominating candidates in a contested election of directors.
Another amendment deals with the 2008 Chancery Court ruling Schoon v. Troy. In that case, Vice Chancellor Stephen P. Lamb ruled a former director was not entitled to advancement of legal fees and expenses in connection with breach of fiduciary duty claims under an amended bylaw. The proposed amendment to the DGCL says that the right to indemnification or advancement provided in the certificate of incorporation or a bylaw can’t be eliminated or impaired after an act or omission that becomes the subject of an investigative action, lawsuit, or proceeding. However, the right can be eliminated retroactively if the indemnification provision at the time of the act authorizes it.
There is also an amendment that proposes to expand the power of Chancery Court. Under Delaware law, only shareholders can remove directors. The amendment would permit the court to remove directors in limited emergency circumstances following conviction of a felony or a judgment for a breach of fiduciary duty.
Elson, Steele, and others have been concerned that measures related to the federal bailout and stimulus bill encroach on governance matters that have historically been handled by the state. But Steele isn’t worried. “We’re still the Tabasco of spice, the Coca-Cola of soft drinks,” he says.
Delaware’s Top Law Firms
Though Delaware is thick with lawyers of all varieties (about 18 per 10,000 residents, third in the nation behind New York and Washington D.C.), it is the absolute Mecca of business law, home to almost 100 corporate law firm offices.
For corporate legal counsel and representation of all types— including audit, mergers and acquisitions, intellectual property, corporate governance, litigation, and bankruptcy—Delaware could be a one-stop shop.
Here are some of its biggest and bestknown firms:
As Delaware’s largest law firm, Richards, Layton & Finger has built its staff of more than 150 attorneys through over a century of providing quality legal services in six different practices to a number of influential clients. Today, the firm’s top attorneys include Robert J. Krapf and Gregory P. Williams.
Young Conaway Stargatt & Taylor has worked with clients ranging from international corporations to small businesses and individuals in need of legal advice and assistance. Its legal staff of 112 has managed many groundbreaking cases, helping to shape the state of Delaware law for more than half a century. Attorneys Bruce L. Silverstein and Robert S. Brady have distinguished themselves in Delaware corporate law.
With almost 100 attorneys, Morris, Nichols, Arsht & Tunnell guides Fortune 500 companies and not-for-profits alike through the intricate pathways of corporate law. Morris Nichols attorneys drafted the Financial Center Development Act of 1981, a piece of legislation that allowed national banks and credit card companies to start work in Delaware. Top governance lawyers at Morris Nichols include A. Gilchrist Sparks III, who was recently named Delaware Lawyer of the Year in corporate law by the Best Lawyers in America Guide.
Having opened its doors in 1826, Potter Anderson & Corroon is Delaware’s oldest law firm and one of its stalwarts. Two of its attorneys, Donald J. Wolfe Jr. and Michael A. Pittenger, authored “Corporate and Commercial Practice in the Delaware Court of Chancery,” the first-ever treatise on the Chancery Court.
M&A powerhouse Skadden, Arps, Slate, Meagher & Flom includes a Wilmington office in its global empire, home to approximately 60 attorneys. Though M&A is a primary focus, the office also works in the practice areas of litigation, restructuring, and class-action litigation. With four offices spread throughout Delaware, Morris James and its staff of 54 attorneys work with clients of all sizes across a variety of practice categories. Founded in 1931 as a two-man practice, the firm has evolved through the years to become a crucial player in Delaware law.
Ashby & Geddes is a Wilmington-based firm best known for its expertise in litigation; its nearly 30 attorneys also conduct a corporate reorganization and insolvency practice. It has earned the highest-possible rating of “AV” from Martindale-Hubbell, the country’s leading legal ratings agency.